Elite Chinese Politics and Political Economy

My name is Victor Shih, currently an assistant professor of political science at Northwestern University specializing in Chinese politics. This blog shares my musing and discussions on Chinese politics and political economy with interested readers. You can contact me at vshih AT northwestern.edu, and my website, where I post my recent research is: http://faculty.wcas.northwestern.edu/~vsh853/

Sunday, February 14, 2010

Expose on Princelings

Really not much to add to this wonderful expose on princeling politics and business by Sydney Morning Herald reporter John Garnaut. I wholeheartedly agree that Bo junior is indeed trying to demonstrate something to somebody by going after Peng Zhen's children and the Deng clan. I think Bo's actions will make the coming two years very interesting...

Children of the revolution

JOHN GARNAUT

February 13, 2010

A sensational court case has exposed the power and connections of China's princelings, writes John Garnaut.

The arrest and kangaroo-court conviction of another successful lawyer might hardly be worth mentioning in a place where imprisoning, deregistering, or beating lawyers for doing their jobs is becoming commonplace. But the case of Li Zhuang has generated a heated 10-week media and internet debate in China, and not just because of the way it was carried out.

It is the first time a lawyer has been convicted of coaching his client to lie on the basis of testimony from mobster, Gong Gangmo, according to another respected lawyer (who has himself been beaten and deregistered for representing the wrong kind of clients). The 4000-word character assassination planted in the China Youth Daily straight after Li's arrest was also unusual.

But it is the background to this case that makes it so riveting for onlookers and disruptive for China's political status quo.

The man who must have authorised Li's arrest is Bo Xilai, the only Politburo member who can comfortably wear epithets such as colourful, mercurial or maverick. The Communist Party boss of the central-west city of Chongqing has captivated the nation with a brave but risky war against the city's organised crime.

Bo got to where he is partly because he is the son of Bo Yibo, one of China's "eight immortals" - the tag for an exalted club of revolutionaries who lived long enough to stamp their marks on China's reform era history.

The China Youth Daily hinted at the equally impressive power behind the lawyer that Bo arrested: "As Li Zhuang arrived at Chongqing, he began to play the peacock, saying many times 'do you know my background? Do you know who my boss is?"

What the censors won't let local media spell out is that Li's law firm is headed by Fu Yang, who is the son of Peng Zhen, also one of the eight immortals and more powerful than Bo Yibo. Li's lawyer from the same Kangda law firm, Gao Zicheng, said he could not talk about the background politics: "I can't go there …''

But the fathers Bo Yibo and Peng Zhen were once factional allies. Their families lived close together and were closely entwined, often entertaining guests at a Shanxi restaurant they both helped to open, says a Beijing political aficionado.

"Both Peng Zhen and Bo Yibo were loyalists of [Mao's one time chosen successor] Liu Shaoqi," says Huang Jing, a visiting professor at the National University of Singapore. "This hate-love relationship is certainly inherited by their children."

So it turns out that Bo Xilai has just spectacularly arrested, convicted and rejected the appeal of a lawyer who works for Bo's equally powerful childhood playmate, Fu Yang.

The Communist Party has enjoyed enormous success in turning China into a powerful nation and lifting its citizens out of poverty. But the party is also a club that allocates political, financial and social privilege to its members. It has its own internal system of hierarchy and quasi-royalty, where revolutionary leaders bequeath their status to their children and children's children. Those descendants are called "princelings" in China.

Mostly, China's princelings get on with expanding the national cake and carving it up. It was Bo Xilai's own father, Bo Yibo, who is said to have helped institutionalise the princeling nexus of power and wealth in the 1990s by supporting a proposal that each powerful family can have only one princeling in politics, leaving other siblings to cash their political inheritances for financial ones.

But the case of lawyer Li Zhuang suggests the country may not be big enough for all of them.

Political analysts say Bo is pursuing an audacious but calculated political strategy. Most say he is appealing directly to the people by implicitly attacking his peers, in the hope of forcing his own promotion into the nine-member Politburo standing committee at the next leadership reshuffle in 2012.

"Bo Xilai is indeed challenging the privilege of some princelings to boost his own popularity," says Bo Zhiyue, an expert on China's princelings at the National University of Singapore.

It's not impossible for an outsider to secure the right patrons and make it to the top, like President Hu Jintao (who was anointed by former party secretaries Hu Yaobang and Deng Xiaoping).

Generally, however, modern China belongs to the children of the revolution. All three officers appointed last year to the rank of full general in the People's Liberation Army were children of senior party leaders. Xi Jinping, who many expect to be the next president, is the son of a revolutionary hero. Eight or nine of the 25-member Politburo are princelings (defined as having a parent or parent in-law who held the rank of vice-minister or above), according to Cheng Li, an expert on Chinese elite politics at the Brookings Institutution. In the previous Politburo there were only three.

The strategic heights of China's economy are also in princeling hands.

The family of former president Jiang Zemin - whose adopted father was a revolutionary martyr - pulls strings in the telecommunications, railways and postal systems. The family of former premier Li Peng - who was adopted by former premier Zhou Enlai - has outsized influence over electricity production, transmission and hydro-electric dam building. His daughter Li Xiaolin, who became famous in Australia this week for her disagreement with Clive Palmer over a $60 billion deal, is at the helm of a major power generating company. Her brother headed another large electricity company before being transferred to help run the coal-powered province of Shanxi. Family friend Liu Zhenya controls the electricity grid.

Distinctions between state and personal enterprise are not always clear in China. Some of the most eminent princeling families discreetly control large companies that are listed on the Hong Kong stock exchange, sometimes in concert with Hong Kong's mega-billionaire families, and often through loyal personal secretaries or close relatives who have changed their names.

Further in the background, Chinese political analysts say the descendants of Marshall Ye Jianying, Deng Xiaoping, Chen Yun, Wang Zhen, Peng Zhen and Bo Yibo are China's real political and financial king makers.

Which brings us back to Bo Yibo and Peng Zhen's children, Bo Xilai and Fu Yang.

Overwhelmingly, China's intellectuals and the legal professionals castigated Bo Xilai (although not by name) for his crackdown in Chongqing and for cloaking himself as a modern day Maoist and making a mockery of the rule of law.

The intellectual tide seemed to turn last week when the accused lawyer, Li Zhuang, shocked his own legal advisers with this open court confession: "I fabricated evidence to deceive the police, the procuratorate, and the court to exculpate Gong."

While that confession was itself clouded in controversy, liberal opinion leaders began to reframe the debate. Li and his law firm, Kangda, are respected for being very good at what they do. But they are also welded into the elite of a Communist Party judicial system that runs on kickbacks and connections.

It is no stretch to say the fathers of Kang Da's three founding principals ran China's entire political-security and judicial systems in the 1980s.

The law firm was itself spun out of the legal department of an immensely profitable and unaccountable corporate-charity empire called Kanghua, which was run by Deng Pufang, son of Deng Xiaoping. Controversy about this type of cronyism was one ingredient in the build up of public unease leading up to the Tiananmen Square demonstrations of 1989.

All that concealed backdrop helps explain why Li was once again the leading chat topic on leading blogging portals this week, after a Chongqing court rejected his appeal but reduced his jail sentence.

"Bo is the great saviour of Chinese ordinary people," said one reader's comment on the People's Daily website. "Strike hard against gangsters and black lawyers. Drag all their [mafia] uncles out!"

And Bo hasn't just locked up one well-connected lawyer who may or may not have been doing his job. In China it is impossible for the mafia to thrive without it being joined at the hip to the Communist Party, as the open trials of some of Bo's nearly 800 gangland prosecutions have shown.

Wen Qiang, Chongqing's former deputy police chief and then justice bureau chief, was in court trying to explain more than 16 million yuan ($2.6 million) of suspected kickbacks and sheltering mobsters such as his sister-in-law, "the godmother of Chongqing".

But it emerged in court for the first time this week that the bulk of Wen's wealth was acquired from payments received in return for handing out promotions.

"The trial of the underworld has become a trial of corrupt officials,'' wrote Liang Jing, the pseudonym of a political columnist on overseas Chinese language websites.

Yang Hengjun, one of China's most influential political commentators, had previously criticised Bo for his Maoist rhetoric and politicisation of the legal process. Last week he took a different course, skating close to the limits of permissible speech, after his email inbox had filled to overflowing with unhappy readers.

Yang wrote that the whole debate about defending "rule of law" in Chongqing was premised on the assumption that there was actually something already resembling "rule of law" anywhere in China, which there patently is not.

"If you are serious about spreading the 'rule of law' in China I have a suggestion," he wrote.

"All legal elites and opinion leaders can join hundreds of thousands of netizens in demanding that Chongqing's fight against gangsters be introduced across the whole nation so that it can terminate unlawful 'rule of law' by corrupt officials."

In the end, writes Yang, debates about rule of law will remain academic in China for as long as it is run by a one-party state: ''Only a greater political system or democracy can provide an answer.''

Privately, close political observers in China say that whatever you think of Bo Xilai or his personal motivations, he has thrown a bomb inside Party Central. His public dissection of Chongqing's power and protection rackets invites Chinese people to worry and talk more openly about whether their country is evolving towards some kind of mafia state.

Some liberal thinkers hope Bo is a catalyst for those in the system who are not beholden to "princelings" - perhaps the Vice-Premier, Li Keqiang - to rise and challenge the party's privileges. But the party's princeling bonds will be hard to break. To the extent that they stick together they will loosen their grip on power only when necessary to preserve it.

"Reporters have every reason to explore the infighting among the princelings,'' writes Cheng Li, at the Brookings Institution.

''But I believe the princelings' incentive for co-operation and the need to share wealth and power are far more important than their internal tensions and conflicts.''

Wednesday, February 10, 2010

Looming Problem of Local Debt in China-- 1.6 Trillion Dollar and Rising

Did China accomplish the impossible? Did it generate almost 9% growth and maintain low debt to GDP ratio even as its export plummeted by 20%? What about claims that the torrent of investment in China has come without too much leveraging? After spending half a year looking into the debt level of local government investment entities-- some 8000 of them-- my conclusion is no. As in the past, the Chinese government just ordered banks to lend to investment companies set up by both central and local governments. Local governments have fully taken advantage of the green light in late 2008 and borrowed an enormous sums from banks and bond investors starting in late 2008 (well, a large amount even before that). In an editorial in the Asian Wall Street Journal yesterday, I outline some problems with this massive amount of borrowing:

Beijing is no longer sure how much money local investment entities have borrowed from banks and raised from bond and equity investors. The amount, however, must be large. In September, the Chinese press, citing government sources, suggested that these entities have borrowed $880 billion (6 trillion yuan). In a January interview with the Twentieth Century Business Herald, a Chinese newspaper, the vice chairman of the Finance and Economic Committee of the National People's Congress, Yi Zhongliu, revealed that local investment entities borrowed some $735 billion in 2009 alone.

These are mere guesses, however. A National Audit Agency audit conducted late last year uncovered so many problems with the data that Premier Wen Jiabao ordered another large-scale audit of local investment entities. Until a thorough audit is completed and the results announced to the public, no one really knows the total scale of local borrowing.

Given the information vacuum surrounding this issue, I spent half a year collecting data that would allow me to provide an estimate of total local debt (and also for each of China's provinces). Again, in the WSJ piece, I briefly outline my methodology and the results in the piece.

To obtain an independent estimate, I collected data from thousands of sources, including regulatory filings, bond-rating reports and press releases of government-bank cooperative agreements. I estimate local investment entities' borrowing between 2004 and the end of 2009 totals some $1.6 trillion. The data are far from perfect because borrowing by low-level government entities and lending by small banks are difficult to track. Nonetheless, my evidence suggests that the scale of the problem is much larger than previous government estimates. At $1.6 trillion, the size of local debt is roughly one-third of China's 2009 GDP and 70% of its foreign-exchange reserves.

So basically, in addition to the 20% of official debt-to-GDP ratio, one has to add an additional 30%. We also have to add other debt that the central government guarantees, such as the nearly 1 trillion RMB in Ministry of Railway bonds and bonds issued by the asset management companies. All of this gives China a high debt to GDP ratio. Also, there are some disturbing implications of this high debt. For one, local governments would have to sell lots and lots of land every year for many years to come to pay interest payment on this debt. Thus, to the extent that there is a real estate bubble today, it must continue for local governments to remain solvent. Regardless of what you believe about Chinese real estate, you have to think that this growth in real estate and land prices must slow or reverse at some point.

I think that the best course of action for the Chinese government is to credibly stop leveraging by local investment companies. Instead of the half measures in place today, a public and stern order should be given to banks to stop lending to all new projects undertaken by these local entities. Other measures should follow:

Since county governments are in the poorest fiscal shape and have the least ability to repay banks, the central government should take over the debt of almost all of the county-level investment vehicles. Although this will increase China's debt-to-GDP ratio significantly, the total would still be low by international standards.

A sudden contraction of lending to local investment vehicles will generate a wave of nonperforming loans, but a greater reliance on market mechanisms can easily solve this problem over the next few years. First, banks will fully recover the debt of the healthiest local entities, which may account for half of total local debt. For the remainder, the government needs to allow banks to directly sell subprime or distressed loans to both foreign and domestic investors. Beijing need not fear that China's listed banks will sell their nonperforming loans at below-market prices, as these banks report to shareholders. Banks, in conjunction with investment banks and distressed-asset investors, should also explore ways to securitize local debt for sale to both domestic and international investors. The latter in particular would have a healthy appetite for yuan-denominated security, anticipating a currency revaluation soon.

Basically, I think the Chinese government can turn this into a great opportunity for market reform in the financial system and the internationalization of the RMB. However, it has to act soon before local debt gets too large to handle.

I'd like to first thank you for putting this together. For some time, I've been very puzzled by the question who is over leveraged in China? Thank for clarifying this.

I have the following questions.

1. Can you share some insight into the distribution of maturity dates of the local government debt (perhaps a chart of debt volume and maturity date)? If most debts are of a long term nature than the potential problem is some what lessened. After all, the best and most affective way to deal with high debt to gdp is to grow gdp rapidly. At China's annual 10% gdp growth rate a lot of debt problems can potentially be grow out of in a few years. On the other hand, if these debt are of a short term nature, than the none performing loan issue for Chinese banks will be a big issue.

By the way, I completely agree with you that China need to reform the financial system and the internationalization of RMB. My comment for the potential of growing out of the debt problem doesn't change that.

2. What are the local governments doing with the debt? 30% of GDP is a lot of money for the local government to take on. It can't just be for the normal operation of the local government. Can you perhaps shed some light on the usage categories of all that money?

3. What is the driver for the demand for residential housing? I understand the incentive for local government to keep the housing bubble going from the supply side. However, local government cannot force people to buy houses. Home ownership in China is already above 80%. Unlike the US, there is no subprime mortgage to attract new marginal buyers of limited means. What is driving up the demand for housing?

I will need sometime to digest this piece and should have more questions. Thank you again for sharing.

""""""""A sudden contraction of lending to local investment vehicles will generate a wave of nonperforming loans, but a greater reliance on market mechanisms can easily solve this problem over the next few years. First, banks will fully recover the debt of the healthiest local entities, which may account for half of total local debt. For the remainder, the government needs to allow banks to directly sell subprime or distressed loans to both foreign and domestic investors. Beijing need not fear that China's listed banks will sell their nonperforming loans at below-market prices, as these banks report to shareholders. Banks, in conjunction with investment banks and distressed-asset investors, should also explore ways to securitize local debt for sale to both domestic and international investors. The latter in particular would have a healthy appetite for yuan-denominated security, anticipating a currency revaluation soon.

"""""""""""A wave of defaults on bad loans will NOT be solved by market mechanisms. More than a few bad loans will render the entirety of the lending universe suspect and credit will freeze. This was demonstrated by mortgage derivatives blowing up two years ago.

That the WSJ would suggest credit derivatives for "overseas sales" is simply insane. It's bad enough that Wall Street itself is running a bucket shop. the world does not need another one.

That the overseas investors would have a "healthy appetite" for suspect Chinese- risk is just flat out wrong. A loss is a loss in any currency. The suggestion that the Yuan will appreciate is also flat out wrong. The yuan is pegged to the now super- hard dollar. The buck is hard because the Saudis have pegged dollars to crude oil.

Oil prices and dollars are bound together in a deathly spiral of deflation. As crude prices decline, the dollar becomes even harder. Good for Saudia, bad for everyone else.

As a consequence of the crude/dollar peg, the various short- dollar- and dollar carry trades are coming apart at the seams.

China is frantic to decouple from the dollar otherwise it will be importing massive USA deflation and kill off its export business at the same time. China has to flood the country with cash and just recently announced raises for Chinese workers.

China has a lot of bad loans, that's the only part of the WSJ's article I can agree with.

Is it possible there are double counting of debt in your analysis of local government debt? Let me elaborate.

I suspect local bureaucrats are forming local business to share in on the central government's largesse for infrasturcture building. These businesses will most likely need to front a lot of the cost of new infrastructure building.

In this scenario, is it possible for both the local and central government to show debt for the same infrastucture project? In this case, the loans the local business take on are ultimately backed by and accounted for by the central government. However, both local and central governments have debt entries on their book.

One thing should always be true. Even local bureaucrats are motivated by profit. I would not be surprise if local bureaucrats don't care about the economic utility of a particular infrasturcture project. However, I would be very surprised if many of these bureaucrats will take out so much debt for business ventures (the bureaucrats most likely have controlling stake) without knowing if someone else, the central government in particular, will ultimately pay.

Thank you for taking the time out in your busy schedule to share your thoughts.